Does inflation targeting reduce sovereign risk? Further evidence

- Many countries have adopted inflation targeting (IT) regimes to build policy credibility.
- We use propensity score matching to analyse whether adopting IT impacts on sovereign risk premia.
- We find that IT reduces sovereign risk premia in IT-adopting countries.
- We conclude that IT reduces the probability of default and with it the risk premium on debt.

We examine whether adopting an inflation-targeting regime helps reduce sovereign risk premia in a sample of 64 advanced and developing countries for the period 1985-2012. We address the self-selection problem of policy adoption by applying a variety of propensity score matching methods. The results provide evidence that inflation targeting lowers sovereign risk.